What has happened
The divergence between US and European equities seen last week, continued into Monday’s session with Europe making gains whist the US equity market fell. In terms of main catalysts, European equities, which have been more exposed to the Ukraine crisis, rose on hopes of a ceasefire agreement between Russia and Ukraine. US equities meanwhile felt the pressure from the upcoming Fed meeting and a growing concern that the central bank’s hawkish message will be bolstered by the recent inflation data and the inflationary impact of the Ukraine conflict and subsequent sanctions.
Following a fourth day of negotiations, negotiators from both sides have gone away to assess next steps in the process. The more positive tone from Sunday continued yesterday with both sides constructive about the possibility of an agreement in the short term. Oil and natural gas prices quickly reflected this more positive outlook with a huge fall yesterday which has continued into today with WTI now below $100/barrel for the first time since the 1st March.
The volatility has continued within the bond market as investors position for a hawkish narrative from the Federal Reserve this week. The market is now pricing in 7 full 25bp Fed hikes over the course of 2022, which is more than was priced in before the Ukraine war began. With the ECB prioritising inflation over geopolitical risk last week, there is a growing expectation that the Fed will note the tail rises of the Ukraine crisis but stress its impact on inflationary pressures primarily. US risk assets reflected this concern yesterday with rates sensitive technology equities underperforming the broader US index. The Treasury curve actually steepened slightly yesterday despite the move higher in rate expectations, this suggests that financial markets expect the US economy to have more resilience in the face of tighter policy based on recent strong data such as the unemployment report.
What does Brooks Macdonald think
As hope builds around a possible resolution in Ukraine, markets quickly shift back to the interest rate hike narrative that dominated at the start of 2022. The Treasury US 10-year yield is now back above 2.1%, erasing the moves lower which were seen during the height of the conflict. When geopolitical fears were at their peak, investors dampened interest rate expectations which in turn kept equity market volatility under control. Should the Fed suggest that it is prioritising inflation over geopolitics, this could remove this release valve and increase future volatility if the Ukraine situation worsens again.
Bloomberg as at 15/03/2022. TR denotes Net Total Return